Preferred Stock Funds vs. Bond Funds

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Man facing many options

Fixed-Income Funds

Preferred Stock Funds vs. Bond Funds

Vanessa Page Sep 29, 2015

Preferred Stock Funds

Preferred stocks are callable loans to investors but have no guarantee of redemption and can literally last the entire life of the company – a feature that is helpful for a company that has issued shares with low dividend payments in a world of rising interest rates. As the interest rate increases, the price of preferred shares will decrease to make the yield more attractive to investors.

Bond Funds

Unfortunately for bond funds, the tax code hasn’t quite closed the gap between the two types of mutual funds. Preferred stock fund payments are treated and taxed as dividends, resulting in a lower tax bill than a similar coupon payment from bond funds.

Who Should Own These Funds?

For example, the Dynamic Preferred Class Yield Fund has an MER of 1.79%, returned 7.5% in 2014, and distributes 0.36% a month. The Dynamic Corporate Bond Strategies Fund has an MER of 1.81% but had a much lower return of 3.7% in 2014 and a monthly distribution of 0.34%. Retirees can feel comfortable with a bond fund that comes with a decent monthly payment but younger investors should shy away from a bond fund that returns 4% less than a slightly riskier preferred stock fund.

But remember, in the event that a company is having financial difficulties, preferred share payments can be suspended. And in the case of liquidation, bondholders are paid ahead of the preferred shareholders.

The Bottom Line

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